Proprietors, Partners, and Corporations (41) Flashcards Preview

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Flashcards in Proprietors, Partners, and Corporations (41) Deck (38)
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1

Sole proprietorships

Sole Proprietorships
The property used by a sole proprietor in operating the business of a sole proprietorship is the property of the sole proprietor. This property may be inventory or capital property.

Capital gains or losses on the disposal of capital property used in the business are capital gains or losses of the sole proprietor.

The sole proprietor can employ and pay a salary to anyone other than himself, including his spouse, common-law partner, or children, provided that the work was necessary and the salary was reasonable in light of the work performed. Any such salaries are deducted as business expenses of the sole proprietorship and reported as taxable income by the employee.

Some provinces prohibit doctors, dentists, lawyers, and public accountants from incorporating their practices.

2

Partnerships

Partnerships
According to various provincial partnership acts, a partner is personally responsible for the debts and liabilities incurred in the course of regular business activity.

Each general partner is said to be jointly and severally responsible for the debts and liabilities of the partnership to the full extent of his personal assets, not just his investment in the partnership. This means that a creditor can obtain a judgement against the partnership and demand payment of the entire amount from any one of all of the partners. Because of this potential for personal financial liability that goes beyond the investment made by the partner, great risk can accompany a partnership interest.

The partner is also personally responsible for any debts and liabilities that arise due to negligence or wrongful acts in the course of business committed by the other partner.

A partner may be liable to another partner for any debts and liabilities arising because the partner violated their partnership agreement or the partner’s negligence cause the loss.

3

What is a partnership

Partnership
The various provincial Partnership acts define a partnership to be the relationship that exists between two or more individuals carrying on an unincorporated business in common with a view of profit.

4

General partnership

A General Partnership is the simplest of partnership, and it can come into existence without any legal formalities, simply by the action of two or more people carrying our business activities together. A general partnership consists only of general partners.

A general partner is a partner who is entitled to take an active role in managing the business, and who have unlimited personal liability for the debts and obligations of the partnership.

Each general partner is said to be jointly and severally liable for the debts and liabilities of the partnership to the full extent of his personal assets, not just his investment in the partnership.

5

Reporting profits within a partnership

Reporting profits within a partnership
The default provisions of the provincial Partnership Acts specify that the income or loss of a partnership is to be shared equally by the partners. However, the total income or loss of a partnership may be allocated among the partners according to their partnership agreement and it can be dependent upon the source of the income, loss or nature of deductions or tax credits.

Although the ITA does not contain specific provisions prescribing how income is to be allocated, it may override the allocation when:
• The principal reason for the agreement may reasonably be considered to the reduction or postponement of income tax; and
• Partners are not dealing at arm’s length partnership of spouses and the allocation is not reasonable considering the capital invested, work performed or other relevant factors

CRA will adjust each partner’ share to an amount which is considered reasonable in the circumstances. In the determination of these amounts, each partner’s capital contribution and work performed, together with any other relevant factor, will be taken into account.

6

Partnership income

Partnership Income
According to the ITA, a partnership is not considered a taxpayer. Instead, it is regarded as a separate vehicle designed to conduct business, whereby income flows through to the partners. The partnership income is taxed in the hands of the individual partners, not at the partnership level. Each partner is taxed at their own effective tax rate based on his share of the partnership’s taxable income for the year.

A partnership interest is a non-depreciable capital property of the partner.

The sale or other disposition of a partnership interest could result in a capital gain to the extent that the proceeds of the disposition exceed the sum of the partner’s adjusted coast base (ACB) and qualifying outlays and expense. It could also result in a capital loss to the extent that the proceeds fall short of the partner’s ACB.

7

Partnerships

Partnerships
Partners do not have to contribute the same type of capital when establishing a partnership. Partners do not have to contribute the same amounts of capital when establishing a partnership.

A partner can contribute depreciable or other capital property to a partnership, instead of cash. Normally, such a transfer would result in a deemed disposition at a FMV, which in turn could result in a deemed capital gain if the property has appreciated in vale. However, partners and their partnerships can jointly elect to rollover the property at the partner’s ACB (or undepreciated capital cost in the case of depreciable property), without realizing a capital gain. Because this rollover is permitted under section 97 of the ITA, it is often called a Section 97 Rollover.

In the absence of a partnership agreement, the default rules of the provincial Partnership Acts specify that the profits and losses are to be shared equally between the partners, regardless of their capital contributions. However, legal entitlements and tax treatment are two different things. If they do not execute a partnership agreement, one of two partners would legally be entitled to 50% of the profits. CRA may decide that one partner should be taxed on more than 50% of the profits, even though he is only legally entitled to receive 50%.

8

Partnership interest

A partnership interest can be acquired either by providing fresh capital to the partnership in the case of a new or expanding partnership, or by purchasing a partnership interest from a retiring partner in the case of an existing partnership. This partnership is a non-depreciable capital property of the partner.

Because it is considered to be a capital property, the sale or the other disposition of a partnership interest can result in a capital gain to the extent that the proceeds of the disposition exceed the sum of the capital partner’s ACB and qualifying outlays and expenses. It can also result in a capital loss to the extent that the proceeds of disposition are less than the ACB.

9

Partnership interest

A partnership interest can be acquired either by providing fresh capital to the partnership in the case of a new or expanding partnership, or by purchasing a partnership interest from a retiring partner in the case of an existing partnership. This partnership is a non-depreciable capital property of the partner.

Because it is considered to be a capital property, the sale or the other disposition of a partnership interest can result in a capital gain to the extent that the proceeds of the disposition exceed the sum of the capital partner’s ACB and qualifying outlays and expenses. It can also result in a capital loss to the extent that the proceeds of disposition are less than the ACB.




10

Benefit of partnerships over incorporation
Can partners be employees of the partnership?
When is partnership income taxed and at what rate?

Partners cannot be employees of the partnership. Even if this was possible, it would not provide a tax advantage, because partnership profits and employment income would both be taxed at the partners’ effective tax rates.

If a partnership experiences a loss, the partners can deduct their share of that loss from their other sources of income. In contrast, a corporation must carry the loss forward to be deducted in a future year. This may give the partnership form of business an advantage over the corporate form in the early (often unprofitable) years of a business if the partners have other sources of income they wish to offset.

Partnership profits are taxed in the hands of the partners at their individual effective tax rates. Partnership profits must be reported by the partners in the year earned, even if the profits are not distributed to the partners in cash.

11

Limited partnership

Limited Partnerships
The characteristics of a limited partnership differ from that of a general partnership in several key ways.

A limited partnership provides limited liability for the debts and liabilities for the one or more of the limited partners provided they do no take part in the active management of the business.

The partners cannot form a limited partnership without a general partner.

The general partner is responsible for the active management of the partnership. General partners are jointly and severally responsible for the debts and liabilities of the partnership. The general partner could be a corporation without any assets.

Under a limited partnership agreement, the limited partners have limited liability for the debts and liabilities generated by the business.

If a limited partner begins to take active management of the company, he will lose his limited liability status and become joint and severally liable with any general partners for any debts and liabilities of the partnership.

A limited partnership cannot exist without a general partner, but provided there is a general partner in place, the partnership can exist with one limited partner.

12

At-Risk and Limited Partners

At-Risk and Limited Partners
Under the at-risk rules, a limited partner can only deduct his share of partnership losses to the extent those losses do not exceed his at-risk amount.

The at-risk rule only applies to limited partners, not general partners.

Each time that partner deducts a loss, it reduces his ACB by the same amount.

13

Corporation as a General Partner for a Limited Partnership

Corporation as a General Partner for a Limited Partnership
A limited partnership must have at least one general partner, which could be a corporation. The general partner would usually be a shell corporation. A shell corporation is a corporation that does not have any significant assets and “employs” the project manager. The project manager could be a corporation, further protecting the participants from liability.

Limited partners are not liable for the debts, obligations, or losses of the partnership, as long as they do participate in the management of the partnership. In other words, the most a limited partner can lose in a partnership is his investment, just like a shareholder in a corporation.

14

Joint Venture

A joint venture is a partnership-like entity that is usually formed to carry out one transaction or a series of transactions over a short period of time. Joint ventures are not treated as partnerships for tax purposes. Instead, they are taxed as business activities of the individual joint venturers who may be individuals, corporations, partnerships, or trusts.

15

Joint Venture

A joint venture is a partnership-like entity that is usually formed to carry out one transaction or a series of transactions over a short period of time. Joint ventures are not treated as partnerships for tax purposes. Instead, they are taxed as business activities of the individual joint venturers who may be individuals, corporations, partnerships, or trusts.

A joint venture is a partnership like entity that is usually formed to carry out one transaction or series of transactions of related transactions over a short period of time. A joint venture can be distinguished from a partnership by the following characteristics.

• A joint venture usually pursues a single business transaction, rather than general and continuous transactions.
• A joint venture can be formed without a profit motive and simply pursue social or recreational purposes
• The agency relationship between members of a joint venture may be more limited than the agency relationship between partners. By that, we mean that whereas a partner mat be able to make decisions on behalf of the entire partnership, the members of a joint venture are limited in terms of the actions they can undertake on behalf of the other members of the joint venture
• When usually pursuing joint goals, corporations are more likely to form a joint venture than a partnership.
In many cases, joint ventures are created by production or theatrical groups to carry out a specific artistic performance, by a mining consortium to develop a mineral property, and by large oil companies to share the risk of exploration.


16

Reporting partnership income
Cash distribtions

All partners in the partnership are required to report their share of partnership profits for tax purposes, even if they do not receive any cash allocations.

A cash distribution is a non-taxable return of capital and decreases the partner’s ACB. A cash distribution are not taxable income.

The cash distributions are deducted from a partner’s ACB, white the partner’s share of profits is added to a partner’s ACB.

17

CCA

CCA
A taxpayer with a home based business could elect to claim a portion of the CCA on the part of his home used for business.

If a taxpayer claims CCA on the business portion of a home, the business portion losses its principal residence status. When the home is sold, any capital appreciation on the business portion of the home for the time that CCA was claimed will be realized as a capital gain.

To the extent that the proceeds exceed (the less of (the un-depreciated capital cost (UCC) and the ACB), the taxpayer has a recapture of the CCA on the business portion of the home.

18

Interest expense - automobiles

You can deduct interest on money you borrow to buy a motor vehicle, automobile, or passenger vehicle that you use to earn income. However, there is a limit on the amount of interest you can deduct.

The lesser of:
-actual interest your paid, or
-$10 x the number of days in the year for which interest was paid or payable.

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The max that a taxpayer can deduct for business expeneses

(lesser of (net income and (home expenses x (the greater of (% of floor space used for business and the number of rooms used by the business as a % of the total number of rooms).

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CCA - Home based business

CCA
A taxpayer with a home based business could elect to claim a portion of the CCA on the part of his home used for business.

If a taxpayer claims CCA on the business portion of a home, the business portion losses its principal residence status. When the home is sold, any capital appreciation on the business portion of the home for the time that CCA was claimed will be realized as a capital gain.

To the extent that the proceeds exceed (the less of (the un-depreciated capital cost (UCC) and the ACB), the taxpayer has a recapture of the CCA on the business portion of the home.

21

Non-capital losses and ABILs

Non-capital losses and ABILs
Non-capital losses include un-deducted ABILs, plus any losses from business, employment or property. Non-capital losses can be deducted from other income of the current year.

All non-capital losses can be carried back 3 years to be deducted from any sources of income in those years.

For the purpose of computing the taxable income of a taxpayer for a taxation year, except as noted below for an allowable business investment loss (ABIL), there may be deducted such portion as the taxpayer may claim of the taxper’s non-capital losses that:

• Arise in the 2006 and subsequent taxation years, for the 20 taxation years immediately preceding.
• Arose in taxation years that ended after March 22, 2004 and before the 2006 taxation years, for the 10 taxation years immediately preceding; and
• Arose in taxation years that ended before mARCH 22, 2004, for the taxation years immediately preceding

Non-capital losses that arise from business employment or property will expire if they are not deducted by the end of the carry forward period.

However non-capital losses that arise from ABILs are treated differently. The carry-forward period for an allowable business loss (ABIL) is only 10 years. An ABIL that you were not able to deduct as a non-capital loss by the end of it’s carry-forward period would become a net capital loss at the end of that year.

You could only deduct a net capital loss from taxable capital gains. You would be able to carry forward the net capital loss indefinitely, but you could only deduct a net capital loss from taxable capital gains.

A taxpayer is not requited to deduct all of her non-capital loss on her return for last year. She should pay attention to her effective tax rate and only deduct the amount of non-capital loss that drops her into her desired tax bracket. By spreading the loss over several years, a taxpayer can optimize the value of the loss carryover.

22

Duty of loyalty

A duty of loyalty is the duty of a partner no to compete with the firm or partnership. Each partner owes a duty of loyalty to the partnership.

“If a partner, with the consent of the other partners, carries on a business of the same nature as and competing with that of the firm, the partner must account for and pay over to the firm all profits made by the partner in that business. “

However, unlike a partnership, shareholders can pursue their own interests to maximize their investment return, and do not owe a duty of loyalty to the corporation.

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Types of dividends a company can issue

Dividends issued by a Corporation
A corporation can issue four distinct types of dividends: regular dividends, capital dividends, capital gains dividends or stock dividends.

A capital dividend is a special dividend payment the flows from a special account called the capital dividend account. This account can include the tax free portion of capital gains, gain from the death benefit of a company owned life insurance policy, and the tax free portion of sales of good will. As a result, this type of dividend is not typically paid on a regular basis. Because capital dividends arise from tax-free sources of income, they are not taxable to shareholders.

After the dividend, the corporation’s cash will be reduced to an amount calculated as:
(cash – capital dividend)

The corporations FMV value will drop to an amount calculated as:
(FMV – capital dividend)

According to the stop-loss rule, if an individual who has control over a private corporation that paid him capital dividends subsequently disposes of those shares and that disposition results in a loss, that loss will be reduced.

The amount of the reduction according to the stop loss rule is the amount calculated as:
The lesser of (A and B)
• A = the sum of all capital dividends that the taxpayer received on those shares; and
• B = the greater of ($0 and (the capital loss – all taxable dividends received by the taxpayer on those shares))
This effectively disallows a capital loss that arises from the payment of a tax free capital dividend, but allows a capital loss arising from the payment of a taxable dividend.

The gain from the death benefit of a life policy is the excess of the death benefit over the ACB of the life policy. The ACB of a term policy is $0.

A capital gains dividend is a distribution of the capital gains of a mutual fund to unit holders.

A stock dividend is a dividend payment by the way of corporation’s stock.
Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayers income for that year in the same manner as if the dividends had been received as cash.

Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayer’s income for that year in the same manner as if the dividend had been received in cash.

If they are paid by a taxable Canadian corporation, stock dividends are subject to the dividend gross up and tax credit scheme.

The amount of the stock dividend for tax purposes is deemed to be equal to the increase in the corporation’s paid up capital that results from the issue of the new shares, and this amount is determined by the corporations directors.

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Types of dividends a company can issue

Dividends issued by a Corporation
A corporation can issue four distinct types of dividends: regular dividends, capital dividends, capital gains dividends or stock dividends.

A capital dividend is a special dividend payment the flows from a special account called the capital dividend account. This account can include the tax free portion of capital gains, gain from the death benefit of a company owned life insurance policy, and the tax free portion of sales of good will. As a result, this type of dividend is not typically paid on a regular basis. Because capital dividends arise from tax-free sources of income, they are not taxable to shareholders.

After the dividend, the corporation’s cash will be reduced to an amount calculated as:
(cash – capital dividend)

The corporations FMV value will drop to an amount calculated as:
(FMV – capital dividend)

According to the stop-loss rule, if an individual who has control over a private corporation that paid him capital dividends subsequently disposes of those shares and that disposition results in a loss, that loss will be reduced.

The amount of the reduction according to the stop loss rule is the amount calculated as:
The lesser of (A and B)
• A = the sum of all capital dividends that the taxpayer received on those shares; and
• B = the greater of ($0 and (the capital loss – all taxable dividends received by the taxpayer on those shares))
This effectively disallows a capital loss that arises from the payment of a tax free capital dividend, but allows a capital loss arising from the payment of a taxable dividend.

The gain from the death benefit of a life policy is the excess of the death benefit over the ACB of the life policy. The ACB of a term policy is $0.

A capital gains dividend is a distribution of the capital gains of a mutual fund to unit holders.

A stock dividend is a dividend payment by the way of corporation’s stock.
Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayers income for that year in the same manner as if the dividends had been received as cash.

Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayer’s income for that year in the same manner as if the dividend had been received in cash.

If they are paid by a taxable Canadian corporation, stock dividends are subject to the dividend gross up and tax credit scheme.

The amount of the stock dividend for tax purposes is deemed to be equal to the increase in the corporation’s paid up capital that results from the issue of the new shares, and this amount is determined by the corporations directors.

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stock dividends

Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayer’s income for that year in the same manner as if the dividend had been received in cash.

If they are paid by a taxable Canadian corporation, stock dividends are subject to the dividend gross up and tax credit scheme.

The amount of the stock dividend for tax purposes is deemed to be equal to the increase in the corporation’s paid up capital that results from the issue of the new shares, and this amount is determined by the corporations directors.

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Types of dividends a company can issue

Dividends issued by a Corporation
A corporation can issue four distinct types of dividends: regular dividends, capital dividends, capital gains dividends or stock dividends.

A capital dividend is a special dividend payment the flows from a special account called the capital dividend account. This account can include the tax free portion of capital gains, gain from the death benefit of a company owned life insurance policy, and the tax free portion of sales of good will. As a result, this type of dividend is not typically paid on a regular basis. Because capital dividends arise from tax-free sources of income, they are not taxable to shareholders.

After the dividend, the corporation’s cash will be reduced to an amount calculated as:
(cash – capital dividend)

The corporations FMV value will drop to an amount calculated as:
(FMV – capital dividend)

According to the stop-loss rule, if an individual who has control over a private corporation that paid him capital dividends subsequently disposes of those shares and that disposition results in a loss, that loss will be reduced.

The amount of the reduction according to the stop loss rule is the amount calculated as:
The lesser of (A and B)
• A = the sum of all capital dividends that the taxpayer received on those shares; and
• B = the greater of ($0 and (the capital loss – all taxable dividends received by the taxpayer on those shares))
This effectively disallows a capital loss that arises from the payment of a tax free capital dividend, but allows a capital loss arising from the payment of a taxable dividend.

The gain from the death benefit of a life policy is the excess of the death benefit over the ACB of the life policy. The ACB of a term policy is $0.

A capital gains dividend is a distribution of the capital gains of a mutual fund to unit holders.

A stock dividend is a dividend payment by the way of corporation’s stock.
Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayers income for that year in the same manner as if the dividends had been received as cash.

Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayer’s income for that year in the same manner as if the dividend had been received in cash.

If they are paid by a taxable Canadian corporation, stock dividends are subject to the dividend gross up and tax credit scheme.

The amount of the stock dividend for tax purposes is deemed to be equal to the increase in the corporation’s paid up capital that results from the issue of the new shares, and this amount is determined by the corporations directors.

The ACB of the new shares is the amount of the dividend prior to the gross up.

The ACB of all his shares is the weighted average cost.


Sometimes corporations will pay a dividend of retained earnings from a gain arising from the special circumstances or a unique event and that the directors do not expect to pay such amounts on a regular or periodic basis. They will sometimes label this as a special circumstance dividend to ensure the shareholders do no expect to receive these amounts on a regular basis.

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Shareholder's agreement

The shareholders of a small business may draft a shareholder’s agreement when first incorporating the company or at any time. The agreement sets out the rights and obligations of the shareholders.

The agreement must be in compliance with the provisions of the Business Corporations Act in the jurisdiction in which the corporation has been incorporated.

The agreement may:
• Include the rules that will govern the running of the corporation
• Outline the rights and responsibilities of the shareholders in running the business
• Stipulate whether loans to shareholders will be permitted
For calculating and taxable benefit from interest-free loans, the interest rate is prescribed as provided for in the ITA.

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CCPC

Canadian Controlled Private Corporation (CCPC) is a Canadian private corporation that is not controlled directly or indirectly by one or more non-residents or public corporations. Canadian control requires that at least 50% plus 1 of the common shares must be owned by Canadian residents.

As a CCPC, business income earned by a corporation up to the business limit for purposes of the small business deduction is taxed at a combined federal and provincial corporate tax rate of about 20%.

The small business deduction is an income tax deduction that currently reduces the federal corporate income tax rate applied to qualifying active business income up to the small business limit of a CCPC to 12%.

The small business limit is the annual amount of active business income eligible for the reduced tax rate.

For 2009 and later years, the small business limit for the small business limit is $500,000.

Under Canadian law, the directors of a corporation do not need to be shareholders in the corporation.

A corporation is a separate legal entity from the shareholders. Accordingly, the corporation can contract with any individual shareholder to be an employee of the corporation.

Only active business income earned by a CCPC is eligible for the small business deduction. Active business income refers to income from the business, but excludes income from property.

For a CCPC, active business income eligible for the small business deduction is taxed at roughly half the basic federal rate.

For 2015, the small business limit form the small business deduction is $500,000.

The small business deduction is only available in respect to active business income earned by a CCPC. Other types of income, such as investment income or income from a personal services business, do not qualify.

The corporation would pay one rate of tax on income up to $500,000 and a higher rate on income greater than $500,000.

Associated corporations must share the annual business limit. If two corporations are owned by the same person, they would be associated corporations.

For 2015, the federal tax rate for income eligible for the small business deduction is 11%.

The provincial corporate income tax rate for income eligible for the small business deduction varies significantly from province to province, but we have assumed that the rate might typically be around 9%

The combined federal and provincial corporate income tax rate for income eligible for the small business deduction is about 20%.

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CCPC bonuses, DPSP, corporate paid RRSPs, dividend payments - how do they effect income of the corporations?

A bonus is an employment benefit to the employee and an employment expense to the employer. A bonus can be accrued on the books of the company and deducted from income tax purposes even its not paid to the employee until the 179 days after the corporation’s year end.
A corporate paid RRSP contribution is a taxable benefit to the employee and an employment expense to the employer.

Dividends paid to shareholders are paid with after-tax profits and are not an expense to the corporation.

Dividends paid to the shareholders are paid with after tax profits and are not an expense to the corporation.

A deferred profit sharing plan (DPSP) is not a taxable employment benefit to the employee, but it is an employment expense to the employer. The funds withdrawan from a DPSP are a taxable benefit to the employee.

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CCPC bonuses, DPSP, corporate paid RRSPs, dividend payments - how do they effect income of the corporations?

A bonus is an employment benefit to the employee and an employment expense to the employer. A bonus can be accrued on the books of the company and deducted from income tax purposes even its not paid to the employee until the 179 days after the corporation’s year end.
A corporate paid RRSP contribution is a taxable benefit to the employee and an employment expense to the employer.

Dividends paid to shareholders are paid with after-tax profits and are not an expense to the corporation.

Dividends paid to the shareholders are paid with after tax profits and are not an expense to the corporation.

A deferred profit sharing plan (DPSP) is not a taxable employment benefit to the employee, but it is an employment expense to the employer. The funds withdrawn from a DPSP are a taxable benefit to the employee.